August 3, 2018 / 2:47 PM / 2 months ago

Breakingviews - Review: The complex causes of the financial crisis

LONDON (Reuters Breakingviews) - There are some wonderful passages in “War and Peace” in which Leo Tolstoy ponders the reasons behind Napoleon’s disastrous invasion of Russia in 1812. Did this great historic event occur because of the French Emperor’s ambition or his Russian counterpart’s resistance, or because of British intrigue or any one of a myriad number of other factors?

A Lehman Brothers employee carries a box away from the office of the U.S. investment bank, in the Canary Wharf district of London on September 15, 2008. The ruptured U.S. financial system faces an unprecedented shake-up with Lehman Brothers filing for bankruptcy, Bank of America buying Merrill Lynch and the Federal Reserve saying for the first time it will accept stocks in exchange for cash loans. REUTERS/Andrew Winning (BRITAIN) - LM1E49F0RWS01

Tolstoy is agnostic: “To us ... who are not historians and are not carried away by the process of research and can therefore regard the event with unclouded common sense, an incalculable number of causes present themselves. The deeper we delve in search of these causes the more we find; and each separate cause or series of causes appears to us equally valid in itself and equally false by its insignificance compared to the magnitude of events.”

Tolstoy’s ruminations spring to mind when one tries to make sense of the global financial crisis, a bloodless event which nevertheless produced untold misery and whose consequences we are destined to live with for a very long time.

As with Napoleon’s campaign, what the then Federal Reserve Chairman Ben Bernanke called the “worst financial crisis in global history” sprung from a multiplicity of causes: the easy money policy of his Fed predecessor Alan Greenspan; a lax approach to financial regulation; academic economists’ poor understanding of credit and speculative bubbles; China’s vast accumulation of dollar reserves, which lowered long-term interest rates; Europe’s incomplete currency union; financial innovations based on flawed mathematical models; a pass-the-parcel credit system; German bankers duped by Wall Street sharks; and the abuse of conflicts of interest by ratings agencies, investment banks, hedge funds, government-sponsored entities and just about everyone else involved in the world of finance.

If Tolstoy were asked why so many individuals contributed to this great historical event he would have replied that it happened because it had to happen. This same historical necessity appears to have shaped the actions of policymakers in the aftermath of the crisis. There was no final reckoning because no one wanted to pick up the tab. Instead, we got a policy of “extend and pretend”.

Too-big-to-fail banks were bailed out and interest rates were set at zero and even lower to shore up the financial system. Another spate of bubbles – in luxury property, technology, modern art, vintage cars and cryptocurrencies – were more or less deliberately inflated. China unleashed a credit-fuelled investment boom, which consumed an ever-greater share of the world’s commodities. The financial sectors in the United States and Britain became even more dominant while miscreant bankers avoided prosecution and their bloated bonuses soon returned. Corporations availed themselves of cheap funding to buy back shares or acquire each other. The global stock of debt continued to grow.

But this attempt to preserve the status quo has had its own consequences. As the rich got richer, the burden of the crisis fell disproportionately on the less well-off. Zombie companies were kept on life support by ultra-low borrowing costs. But productivity growth collapsed, with the result that incomes stopped growing. In the periphery of Europe, unemployment climbed to levels last seen in the 1930s. As the people of the Anglosphere continued to live beyond their means, China continued to eviscerate their manufacturing sectors. The public’s acceptance of globalisation weakened.

Adam Tooze is best known for his work on the economy of Nazi Germany. In “Crashed: How a Decade of Financial Crises Changed the World”, he brings a historian’s understanding to the financial crisis and its aftermath. Tooze handles the implied task bequeathed by Tolstoy – to do justice to the vast multiplicity and complication of contributing events – with aplomb. The result is an ambitious narrative which runs from the United States, through Western Europe into Central Europe, across the steppes of Russia and onwards to China.

Nor does Tooze merely marshal information already familiar to many of his readers. He seeks to change their understanding of the crisis. Initially, the outbreak of financial turbulence was depicted as a subprime mortgage crisis originating on Wall Street. Drawing on research from the Bank for International Settlements, Tooze argues it’s more accurate to see the events that unfolded a decade ago as a crisis of transatlantic finance. European banks were heavily exposed to low-quality mortgages, which they funded by borrowing in US dollars. When the crisis hit, these banks suddenly found themselves short trillions of dollars. Bernanke came to the rescue, lending the necessary dollars to the European Central Bank and other monetary authorities. It was the Fed’s currency swaps, rather than zero interest rates or quantitative easing, which staved off a repeat of the Great Depression.

Tooze’s detailed depiction of the euro zone crisis is another of the book’s strong points. He shows how the Germany of Chancellor Angela Merkel was incapable of driving the political reforms – the banking and fiscal unions – necessary to make the single currency viable. Instead, German politicians forced austerity on Europe’s periphery. Democratic opposition in Greece and other countries to Berlin’s diet of gruel was overridden. As former German Finance Minister Wolfgang Schaeuble pointed out, elections change nothing. In the end, it was only the promise by ECB President Mario Draghi to “do whatever it takes”, later backed up with negative interest rates and lashings of quantitative easing, that prevented the euro zone from falling apart.

The greater the distance from current events, the more slowly the river of history flows. As the present approaches, those waters turn torrential and the historian’s navigational task becomes impossible. The earlier parts of “Crashed” describe in detail the numerous failures of the policymaking elite and its unwavering protection of vested interests. Yet Tooze is baffled by Britain’s Brexit referendum and flummoxed by the election of Donald Trump. At this point, he casts off the role of dispassionate historian and vents his liberal spleen. It makes for a disappointing conclusion to an otherwise impressive work.

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